Legal hopes give new lift to Fannie, Freddie stock

July 18, 2014, 12:54 PM ET

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Common and preferred shares in Fannie Mae and Freddie Mac rose this week after a legal ruling in favor of plaintiffs suing the government, but analysts say investors in the federally controlled mortgage-finance giants may not be any better off in the long run.

On Wednesday Judge Margaret Sweeney in the U.S. Court of Federal Claims ordered that the discovery process in Fairholme Funds’ suit against the government can proceed.

“The proper approach is for a court to examine the factual underpinnings and legal contentions presented by the complaint, in order to determine whether the exercise of its jurisdiction is proper,” Sweeney wrote.

Common shares of Fannie  FNMA  and Freddie FMCC  rose almost 9% and 10%, respectively, on Wednesday. Meanwhile, the most heavily traded preferred series of Fannie FNMAS and Freddie FMCKJ  – these series are less liquid than the common shares and tend to be held by long-term investors — rose more than 2% and 3%, respectively.

Fairholme, a major Fannie and Freddie investor, is suing over the government’s 2012 amendment to its bailout agreement that forces Fannie and Freddie to send all of their profit to the Treasury Department, thereby preventing investors such as Fairholme from receiving dividends. U.S. lawmakers have offered several proposals to wind down Fannie and Freddie, but are likely leaving thorny issues over shareholder compensation to the courts.

While Sweeney’s decision is helpful for Fairholme, it wasn’t entirely unexpected and is far from a final ruling in investors’ favor, analysts at Keefe, Bruyette & Woods, a New York-based investment bank, wrote in a research note.

“Courts usually err towards allowing more discovery rather than less and we thought the government’s claim of privilege to not disclose some documents was overly broad and unlikely to prevail in court,” KBW analysts wrote. “We remain skeptical that Fairholme will win its argument that the government has illegally seized the plaintiff’s private property (i.e., dividends).”

–Ruth Mantell